Is Alpha and Omega Semiconductor (NASDAQ:AOSL) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Alpha and Omega Semiconductor Limited (NASDAQ:AOSL) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Alpha and Omega Semiconductor

What Is Alpha and Omega Semiconductor's Debt?

The image below, which you can click on for greater detail, shows that Alpha and Omega Semiconductor had debt of US$22.7m at the end of December 2021, a reduction from US$136.7m over a year. However, it does have US$269.3m in cash offsetting this, leading to net cash of US$246.6m.

How Strong Is Alpha and Omega Semiconductor's Balance Sheet?

The latest balance sheet data shows that Alpha and Omega Semiconductor had liabilities of US$178.0m due within a year, and liabilities of US$139.9m falling due after that. Offsetting this, it had US$269.3m in cash and US$57.7m in receivables that were due within 12 months. So it actually has US$9.15m more liquid assets than total liabilities.

This state of affairs indicates that Alpha and Omega Semiconductor's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$1.26b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Alpha and Omega Semiconductor boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Alpha and Omega Semiconductor grew its EBIT by 537% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Alpha and Omega Semiconductor can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Alpha and Omega Semiconductor may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Alpha and Omega Semiconductor actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Alpha and Omega Semiconductor has net cash of US$246.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 147% of that EBIT to free cash flow, bringing in US$112m. So is Alpha and Omega Semiconductor's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Alpha and Omega Semiconductor (2 are potentially serious) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.